CEPA
Center for Economic Policy Analysis
Recasting the International Financial Agenda
José Antonio Ocampo (United Nations ECLAC)
CEPA Working Paper Series III
International Capital Markets and the Future of Economic Policy
A Project Funded by the Ford Foundation
Working Paper No. 19
November 2000
Center for Economic Policy Analysis
New School for Social Research
80 Fifth Avenue, Fifth Floor, New York, NY 10011-8002
Tel. 212.229.5901 ! Fax 212.229.5903
www.newschool.edu/cepa
Final draft
November, 2000
RECASTING THE INTERNATIONAL FINANCIAL AGENDA
José Antonio Ocampo */
The recent phase of financial turmoil that started in Asia, crossed through Russia and
reached Latin America generated a deep sense that fundamental reforms were required in the
international financial architecture to prevent and improve the management of financial crises.
The crisis led, indeed, to a recognition that there is an enormous discrepancy between the
sophisticated and dynamic financial world and the institutions that regulate it, that “existing
institutions are inadequate to deal with financial globalization” 1/.
The crisis set in motion positive responses: a concerted expansionary effort led by the
United States in the midst of the crisis, which was probably the crucial step that facilitated the
fairly rapid though incomplete normalization of capital markets; the approval of new credit lines
and the expansion of IMF resources; the recognition that incentives must be created to induce
adequate debt profiles in developing countries, and that some capital account regulations may
serve this purpose and provide a breathing space for corrective macroeconomic policies; the
parallel recognition that financial liberalization in developing countries should be carefully
managed and sequenced; a special impetus to international efforts to establish minimum
standards of prudential regulation and supervision, as well as of information; the acceptance that
no exchange rate regime is appropriate for all countries under all circumstances; the partial
acceptance by the IMF that fiscal overkill is inappropriate in adjustment programs; the
improvement of the Highly Indebted Poor Countries’ (HIPC) Initiative; and the greater emphasis
given to the design of adequate social safety nets in developing countries 2/.
*
/ Executive Secretary, United Nations Economic Commission for Latin America and Caribbean (ECLAC). The
paper partly draws upon parallel work by the author, as coordinator of the Task Force of the United Nations
Executive Committee on Economic and Social Affairs (United Nations Task Force, 1999), as well as from Ocampo
(1999, 2000a) and joint work with Stephany Griffith-Jones (Griffith-Jones and Ocampo, 1999), supported by the
Swedish Ministry of Foreign Affairs.
1
/ United Nations Task Force (1999), Section 1.
2
/ See on some of these issues, the regular reports of the IMF Managing Director to the Interim, now International
Monetary and Financial Committee. See IMF (1999, 2000a, 2000b).
1
Some responses were positive but do not seem to be leading in any clear direction (or
even in a wrong one). This is the case of the adoption of collective action clauses in debt issues
as an essential step to facilitate internationally agreed debt standstills and orderly workout
procedures. In some cases, the responses were insufficient or clearly inadequate: IMF
conditionality was overextended; the need for stable arrangements to guarantee the coherence of
the macroeconomic policies of industrialized countries did not receive sufficient scrutiny; the
Japanese proposal to create an Asian Monetary Fund gave rise to strong unwarranted opposition
that led to its rapid dismissal (though there has been a recent revival of this idea); more
generally, the role which regional institutions can play in an appropriate international financial
arrangement was not given adequate attention; and no (or only very partial) steps were taken to
ensure a fair representation of developing countries in the discussions on reform or in a revised
international architecture.
The fairly rapid normalization of capital markets gave way to a sense of complacency
that slowed down the reform effort. Moreover, it could lead efforts in the wrong direction. One
such step would be to give new impetus to discussions on capital account convertibility. The
calmer environment could be taken, on the other hand, as an opportunity to broaden the agenda
and to set in motion a representative, balanced negotiation process. The ongoing process for a
United Nations Consultation on Financing for Development in 2001 constitutes an important
opportunity in this regard. The agenda should be broadened in at least two senses: first of all, it
should go beyond the issues of financial crisis prevention and resolution (which may be termed
the “narrow” financial architecture 3/) to include those associated with development finance and
the “ownership” of economic and, particularly, development policies; secondly, it should
consider, in a systematic fashion, not only the role of world institutions, but also of regional
arrangements and the areas where national autonomy should be maintained. This is the focus of
this paper. As a background, the first section presents brief reflections on the nature of the
problems that the system faces and the political economy of the reform effort. Then the paper
deals with crisis prevention and management, development finance, the issue of conditionality
3
/ Ocampo (2000a).
2
vs. “ownership” which concerns both of them, the role of regional institutions, and national
regulations and autonomy. The last section draws some conclusions.
I.
THE NATURE OF THE PROBLEMS THAT THE SYSTEM FACES
International capital flows to developing countries have exhibited four outstanding
features in the 1990s 4/. First of all, official and private flows have exhibited opposite patterns:
whereas the former have tended to decline, private capital flows have experienced rapid
medium-term growth. Secondly, different private flows have exhibited striking differences in
terms of stability. Thirdly, private flows have been concentrated in middle–income countries,
with official flows playing only a very partial redistributive role at the global level. Finally, the
instability of private financial flows has required the design of major emergency rescue
packages, of unprecedented size, which have concentrated funds in a few large “emerging”
economies.
The first two patterns are shown in Table 1. Both foreign direct investment (FDI) and all
types of private financial flows have experienced strong medium–term growth. However, these
flows have exhibited striking differences in terms of stability: whereas FDI has been resilient in
the face of crises, private financial flows have experienced strong volatility and “contagion”
effects. In contrast, official development finance and particularly its largest component, bilateral
aid, has lagged behind. Indeed, bilateral aid has tended to fall throughout the decade and
currently stands at one–third of the internationally agreed target of 0.7% of the GDP of
industrialized countries 5/. The reduction in bilateral aid has been strongest in the case of the
largest industrialized countries. This trend has been partly offset, in terms of effective resource
transfers, by the increasing share of grants in official development assistance. Also, contrary to
private flows, official finance has not been pro–cyclical and, indeed, some components of it –
particularly balance of payments support but also multilateral development finance—has
displayed anti–cyclical behaviour.
4
5
/ For a full evaluation of trends, see UNCTAD (1999), Chapters III and V, and World Bank (1999, 2000).
/ World Bank (2000), p. 58.
3
The third pattern is shown in Table 2. Private flows have been strongly concentrated in
middle–income countries. The share of low–income nations in private financing has been lower
than their share in the total population of developing countries, a fact that may be expected, but it
is also lower than their share in developing countries’ GDP. This fact is particularly striking in
bond financing, commercial bank lending and portfolio flows, if India is excluded in the latter
case. In all these cases, private financing to poor countries is minimal. The share of low–income
countries in FDI is also smaller than their contribution to developing countries’ GDP. Moreover,
a striking feature of FDI is its high concentration in China, which captures, on the contrary, a
smaller proportion of financial flows. The high concentration of the most volatile flows in
middle-income countries, excluding China, has implied, in turn, that issues of financial volatility
and contagion are particularly relevant to them.
Low–income countries have thus been marginalized from private flows and have
continued to depend on declining official sources of resource flows. They have, indeed, been
strongly dependent on official development assistance, particularly grants, coming mostly in the
form of bilateral aid. If we again exclude India, this is the only component of the net resource
flows to developing countries that is highly progressive, in the sense that the share of low–
income countries exceeds not only their share in developing countries’ GDP but also in
population. This is also marginally true of multilateral financing, excluding the IMF.
4
TABLE 1
a
NET LONG-TERM FLOWS TO DEVELOPING COUNTRIES , 1990-1999
Total
Official flows
Private flows
From international capital markets
Private debt flows
Commercial bank loans
Bonds
Others
Portfolio equity flows
Foreign direct investment
1990
98.5
55.9
42.6
18.5
15.7
3.2
1.2
11.3
2.8
24.1
1991
124.0
62.3
61.6
26.4
18.8
5.0
10.9
2.8
7.6
35.3
1992
153.7
54.0
99.7
52.2
38.1
16.4
11.1
10.7
14.1
47.5
1993
219.2
53.4
165.8
99.8
48.8
3.5
36.6
8.7
51.0
66.0
1994
220.4
45.9
174.5
85.7
50.5
8.8
38.2
3.5
35.2
88.8
1995
257.2
53.9
203.3
98.3
62.2
30.4
30.8
1.0
36.1
105.0
1996
313.1
31.0
282.1
151.3
102.1
37.5
62.4
2.2
49.2
130.8
1997
343.7
39.9
303.9
133.6
103.4
51.6
48.9
3.0
30.2
170.3
a
1998
318.3
50.6
267.7
96.8
81.2
44.6
39.7
-3.1
15.6
170.9
Net long-term resource flows are defined as net liability transactions of original maturity greater than one year. Although the Republic of Korea is a
high-income country, it is included in the developing country aggregate since it is a borrower from the World Bank.
b
Preliminary.
Source: The World Bank, Global Development Financ e 2000, (http://www.worldbank.org/prospects/gdf2000/vol1.htm), April 4, 2000.
5
b
1999
290.7
52.0
238.7
46.7
19.1
-11.4
25.0
5.5
27.6
192.0
TABLE 2
NET FLOW OF RESOURCES , 1992-1998
(Annual averages, billion dollars and percentages)
Foreign direct
investment
Amount Percentage
Developing countries
Excluding China
Portfolio equity
flows
Percentage
Amount
Grants
Amount
Bilateral financing
Percentage Amount
Percentage
Multilateral financing
(excluding IMF)
Amount
Percentage
109.4
75.4
100.0
68.9
33.0
29.4
100.0
89.2
28.0
27.7
100.0
99.0
2.3
0.3
100.0
13.1
15.3
13.1
100.0
86.0
7.4
1.8
5.6
6.8
1.6
5.1
3.0
2.2
0.8
9.0
6.6
2.4
16.2
0.5
15.7
58.0
2.0
56.1
0.8
-0.3
1.1
36.7
-11.2
48.0
5.8
1.0
4.8
37.8
6.4
31.5
China
34.0
31.1
3.6
10.8
0.3
1.0
2.0
86.9
2.1
14.0
Middle-income countries
Argentina
Brazil
Russian Federation
Indonesia
68.0
5.2
9.8
1.9
3.0
62.1
4.7
8.9
1.8
2.7
26.4
1.5
3.6
1.0
2.1
80.2
4.5
10.9
3.0
6.4
11.4
0.0
0.1
1.0
0.2
40.9
0.1
0.2
3.5
0.8
-0.5
-0.2
-1.1
0.5
1.2
-23.6
-10.1
-49.6
21.6
52.8
7.4
1.0
0.7
0.9
0.3
48.2
6.5
4.9
5.9
2.0
2.0
8.8
37.3
1.9
8.0
34.1
3.5
4.5
10.3
10.5
13.6
31.3
0.0
0.0
10.1
0.0
0.1
36.2
0.1
-0.7
-0.3
3.1
-28.8
-12.6
1.1
0.3
3.0
7.4
2.0
19.6
Other loans
Total
Amount Percentage
Amount
Low-income countries
India
Other countries
a
b
Republic of Korea
Mexico
Other countries
Bonds
Commercial bank
loans
Amount
Percentage
Memo:
Amount
Percentage
Percentage
GDP
Population
Developing countries
Excluding China
38.2
36.6
100.0
95.7
27.5
26.7
100.0
97.0
3.7
0.3
100.0
8.7
257.4
209.5
100.0
81.4
100.0
89.3
100.0
74.8
Low-income countries
India
Other countries
1.0
0.9
0.1
2.7
2.4
0.3
0.7
0.5
0.3
2.6
1.6
0.9
1.1
0.2
0.9
29.5
5.9
23.5
36.0
6.8
29.2
14.0
2.6
11.4
11.3
5.3
6.0
40.7
19.4
21.3
a
China
Middle-income countries
Argentina
Brazil
Russian Federation
Indonesia
b
Republic of Korea
Mexico
Other countries
1.6
4.3
0.8
3.0
3.4
91.3
47.9
18.6
10.7
25.2
35.6
5.9
3.1
2.3
1.4
93.0
15.4
8.0
6.0
3.6
26.0
1.2
9.6
1.1
0.3
94.4
4.5
34.7
4.0
1.2
-0.8
0.0
-0.5
1.1
0.1
-20.8
-1.3
-13.3
29.0
2.9
173.5
14.5
25.2
9.8
8.6
67.4
5.6
9.8
3.8
3.4
78.0
4.7
10.3
6.6
3.1
34.1
0.7
3.3
3.1
4.0
6.8
4.8
11.4
17.7
12.6
29.7
0.7
1.6
11.5
2.5
5.8
41.7
-0.4
-0.4
-0.6
-10.4
-10.9
-16.8
13.8
19.0
82.7
5.3
7.4
32.1
6.8
6.1
40.4
0.9
1.9
20.1
a
The World Bank considered China as a low-income country until 1998. Since 1999 it has been classified as a middle-income country. In this table it is considered as
a specific category.
b
The World Bank classifies it as a high-income country, but it is included as a middle-income country in Global Development Finance 2000 .
Source: The World Bank, Global Development Finance, (CD-ROM), 2000 (advance release) , Washington, D.C., 2000 and World Economic Indicators 1999 ,
Washington, D.C., 1999 for GDP and population data.
The volatility of private financial flows, on the one hand, and its strong concentration in
middle–income countries, on the other, have jointly generated the need for exceptional financing
on an unprecedented scale, which has been concentrated in a few “emerging” countries. As a
result, IMF (including ESAF) financing has exhibited both strong anti–cyclical behaviour in
relation to private flows and a concentration in a few countries. As Figure 1 indicates, both
patterns are closely associated, as cyclical borrowing by a few countries is the major determinant
of the overall cyclical pattern. The latter feature has become even more marked in recent years.
Thus, whereas India and the three largest Latin American borrowers received less than half of net
real flows from the Fund in 1980–1984, net real flows to only four large borrowers (Indonesia,
Republic of Korea, Russia and Mexico) accumulated close to 90% of total net real flows from
6
the Fund in 1995–1998. As a result of this feature, the share of IMF financing going to large
borrowers 6/ has displayed a strong upward trend over the past two decades. Indeed, in recent
years, IMF financing underestimates the magnitude of emergency financing to large borrowers,
as the bilateral contributions to the rescue packages of six nations (Indonesia, Republic of Korea,
Thailand, Russia, Brazil and Mexico) are not included in the data 7/.
Strictly speaking, however, “crowding out” by the largest borrowers does not seem to
have taken place, as overall Fund financing has responded elastically to the needs of these large
borrowers, with financing to other poorer or smaller middle–income countries remaining
stagnant or even increasing marginally when they also require additional balance of payments
financing. This was the case in the 1980s for much of the developing world and has also been
true of the supply of financing to the smaller East Asian and Pacific nations in recent years. In
any case, Fund and counterpart bilateral liquidity financing have complemented private funds
through the business cycle. Given the high concentration of private financing in middle–income
countries, this has led to a similar pattern of concentration in the case of official liquidity
financing. In the context of a significant scarcity of official financing for low–income countries,
the high concentration of balance of payments financing in a few large “emerging” economies
raises significant concerns as to the global rationality with which global capital flows, and even
official flows, are distributed. It certainly raises question about whether the problems of the
largest developing countries generate specific biases in the response of the international
community.
Thus, although the volatility and contagion exhibited by private capital flows, the centre
of recent debates, are certainly problematic, no less important problems are the marginalization
of the poorest countries from private capital flows and the decline in the bilateral aid on which
they largely depend. International financial reforms must thus be focused also on guaranteeing
solutions to all these problems. Moreover, the debt overhang of many developing countries,
particularly poor ones, continues to weigh heavily on their development possibilities.
6
/ This group includes Argentina, Brazil, China, Indonesia, India, the Republic of Korea, Mexico and the Russian
Federation.
7
/ It must be emphasized, however, that pledged bilateral financing tends to be disbursed in smaller proportions than
the multilateral shares in rescue packages.
7
FIGURE 1
USE OF IMF CREDIT
AMOUNTS
110,000
100,000
90,000
80,000
MILLION OF 1995 US$
70,000
60,000
50,000
40,000
30,000
20,000
10,000
Low-income countries, excluding India
Low middle-income countries, excluding China, Rusia e Indonesia
High middle-income countries, excluding Argentina, Brasil y México
Large Borrowers
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
0
COMPOSITION
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
Low-income countries, excluding India
Low middle-income countries, excluding China, Rusia e Indonesia
High middle-income countries, excluding Argentina, Brasil y México
Large Borrowers
8
1998
1997
1996
1995
1994
1993
1992
1991
1990
1989
1988
1987
1986
1985
1984
1983
1982
1981
1980
1979
1978
1977
1976
1975
1974
1973
1972
1971
1970
0%
II.
FINANCIAL CRISIS PREVENTION AND RESOLUTION
A.
Improving the institutional frameworks in which financial markets operate
The issues associated with financial crisis prevention and resolution have received
extensive attention in recent discussions 8/. The most important area of agreement relates to the
need to improve the institutional framework in which financial markets operate: to strengthen
prudential regulation, supervision and accounting practices of financial systems worldwide; to
adopt minimum international standards in these areas, codes of conduct of fiscal, monetary and
financial policies, and sound principles of corporate governance; and to improve the information
provided to financial markets. From the point of view of industrialized countries, the central
issues are stricter regulation and supervision of highly leveraged institutions and operations,
controls on offshore centres, and the greater weight that should be given to the risks associated
with operations with countries engaging in large-scale net borrowing, particularly of a short-term
character, to discourage risky financing at the source. In this regard, it should be emphasized
that, despite the recognition of the central role that strengthening regulations of highly leveraged
institutions has, moves in this direction have rather timid and biased towards indirect rather than
direct regulations.
From the point of view of borrowing economies, greater weight should be given by
domestic regulators to the accumulation of short-term liabilities in foreign currencies, to risks
associated with the rapid growth of credit, to currency mismatches of assets and liabilities, and to
the valuation of fixed assets as collateral during episodes of asset inflation. Most importantly,
due account should be taken of the links between domestic financial risks and changes in key
macroeconomic policy instruments, notably exchange and interest rates. This indicates that
prudential standards should be stricter in developing countries, where such links are more
important, and that they should be strengthened during periods of financial euphoria to take into
account the increasing risks being incurred by financial intermediaries. Due account should also
be taken of the important externalities which large non-financial firms could generate for the
8
/ See, among others, IMF (1998, 1999, 2000), IMF Interim Committee (1998), Group of Seven (1998), UNCTAD
(1998), Part One, Chapter IV, United Nations Task Force (1999), ECLAC (2000b), Miyazawa (1998), Rubin (1999),
Summers (1999), Camdessus (1998, 2000), Fischer (1999), Akyüz and Cornford (1999), Eatwell and Taylor (2000),
Eichengreen (1999), Griffith-Jones (1998), Griffith-Jones and Ocampo (1999), Ocampo (1999, 2000a), White
(2000a, 2000b) and Wyplosz (1999).
9
domestic financial sector, which implies that the external liabilities exposure of these firms
should also be regulated. We will return to these issues below.
Nonetheless, a substantial divergence of opinion remains. Firstly, there is no consensus as
to which institutions should be entrusted with enhanced responsibilities in this field. The BIS
should certainly play the leading role, but this requires a significant expansion of
developing-country membership in this organization. The more ambitious proposal to create a
World Financial Authority on the basis of BIS, IOSCO and IAIS should also be considered 9/.
Secondly, the lack of adequate representation of developing countries in the definition of all sorts
of international standards and codes of conduct is a basic deficiency of current arrangements 10/ –
which the launching of the G-20 only partly solves—and violates the central principle that G.K.
Helleiner has formulated: “No harmonization without representation”
11
/. It also works against
the necessary adaptation of rules to developing country conditions 12/.
Thirdly, although the essential role of regulation and supervision is to make financial
intermediaries more risk-conscious, there are clear limits to the appropriateness of discouraging
private risk-taking. Stronger prudential regulation in developing countries increases the costs of
domestic financial intermediation and thus encourages the use of more external borrowing in the
absence of adequate regulation of the latter. Fourthly, differences exist as to the relative merits of
prudential regulations and supervision vs. alternative instruments in key areas. One particularly
relevant issue in this regard, as we will in Section VI, relates to capital account regulations.
Moreover, there are significant differences of opinion as to what can be expected from enhanced
prudential regulation and supervision, given their inherent limitations. Regulations will tend to
lag behind financial innovations, supervisors are likely to face significant information problems,
and macroeconomic events may overwhelm even well-regulated systems. Finally, traditional
prudential regulation and supervision tend to have pro-cyclical macroeconomic effects (they may
be unable to avoid excessive risk-taking during the booms but accelerate the credit crunch during
9
/ Eatwell and Taylor (2000).
/ A very strong statement in this regard has been recently been made by the Governor of the People’s Bank of
China: “The monopoly by a handful of developed countries on the rule-making in the international financial field
must be changed” (Dai, 2000).
11
/ Helleiner (2000a).
12
/ Ahluwalia (1999).
10
10
crises, when bad loans become evident and the effects of provisioning standards are thus felt), a
fact which may increase rather than decrease credit risks through the business cycle.
Equally important, there is some doubt as to what can be expected from better
information. Indeed, although improved information enhances microeconomic efficiency, it may
not improve macroeconomic stability, which is dominated by the evolution of opinions and
expectations rather than information, in the correct sense of that term (i.e., factual information).
Indeed, the tendency to equate opinions and expectations with “information” is one of the
greatest weaknesses in the recent literature. Well-informed agents (rating agencies and
institutional investors, for example) are equally subject to the whims of opinion and
expectations, a fact that accounts for their inability to stabilize markets and, indeed, under certain
conditions, the additional instability which they may generate
13
/. To use modern terminology,
more than “information cascades”, what characterizes macroeconomic financial instability are
“opinion and expectation cascades”, i.e., the alternate “contagion” of both optimism and
pessimism through the business cycle. The best information system will be unable to correct this
“market failure”, as the whims of expectations involve “information” about the future, which
will never be available 14/. Developing countries have also strongly argued for “a symmetrical
application of transparency criteria between public institutions and the private sector”
15
/ and
thus against the tendency to emphasize the former over the latter in current proposals. Heated
debates still surround the advantages vs. the disadvantages of the disclosure of IMF surveillance
reports, which reflect the relative virtues of greater information and transparency vs. “the
importance of maintaining the Fund’s role as confidential and trusted advisor” 16/.
13
/ See, on the former, Larraín et al. (1997); on the latter, Calvo (1998).
/ For a more extensive analysis, see Ocampo (2000a). Keynes’ concept of a “beauty contest” is thus much more
appropriate to analyze the volatility of expectations, as Eatwell (1996) and Eatwell and Taylor (2000) have
emphasized.
15
/ Group of 24 (1999a).
16
/ Group of 24 (1999b). See a more extensive discussion of this issue in IMF (1999, 2000a, 2000b).
14
11
B.
The need for coherent macroeconomic policies worldwide
The consensus on the need to strengthen the institutional framework in which financial
markets operate has not been matched by a similar emphasis on the role played by the coherence
of macroeconomic policies worldwide, i.e., on appropriate mechanisms to internalize the
externalities generated by national macroeconomic policies. A particularly crucial area, which
the G-24 and other analysts have emphasized, are the high costs that fluctuations among major
currencies have for developing countries 17/.
The need for coherent macroeconomic policies is crucial in relation to both booms and
crises, but the need to strengthen the extremely weak existing arrangements is particularly crucial
during booms, when IMF surveillance is perceived by national authorities as an academic
exercise, consultative mechanisms seem less necessary and “market discipline” has perverse
effects, as it does not constrain excessive private risk-taking or the adoption of national procyclical policies. Indeed, the focus of current institutions –both national and international— on
crises rather than booms is a serious deficiency of existing arrangements, as they underplay the
preventive role that they should perform. Obviously, concerted expansionary action during crises
is also essential and, as was pointed out in the introduction to this paper, moves in that direction
since the Russian crisis were probably the single most important reason for the relative though
incomplete normalization of capital markets in 1999.
The lack of adequate representation of developing countries in existing organs is another
deficiency of current arrangements, as the composition of the IMF’s International Monetary and
Financial Committee reflects. Given the more adequate balance in the representation of
developing and developed countries, the United Nations could play an enhanced role in the
normative area, either through an improved Economic and Social Council or an Economic
Security Council.
17
/ See Group of 24 (1999b, 2000). See also the different points of view on this issue in Council on Foreign
Relations (1999).
12
C.
Emergency financing
The enhanced provision of emergency financing during crises is the third pillar of the
system to prevent and manage financial crises. This principle may be called the principle of the
“emergency financier”, to differentiate it from the role that central banks play at the national
level as “lenders of last resort”, which is not exactly matched by the IMF. More specifically, the
Fund provides exceptional financing but certainly not liquidity, a fact that is reflected in the lack
of automaticity in the availability of financing during crises
18
/. The access to emergency
financing raises, in any case, “moral hazard” issues that give rise, on the side of borrowers, to the
need to define access rules and, on the side of private lenders, to the need for orderly debt
workouts that guarantee that they assume a fair share of the costs of adjustment.
The main lessons from recent crises are: (1) that, as a preventive measure, wider use
should be made of private contingency credit lines that are agreed during periods of adequate
access to capital market, following the (partly successful) pioneering experiences of some
“emerging” economies; (2) that large-scale official emergency funding may be required, though
not all of it needs to be disbursed if support programs rapidly restore market confidence; (3) that
funds should be made available before --rather than after-- international reserves reach critically
low levels; and (4) that, due to strong contagion effects, contingency financing may be required
even by countries that do not exhibit fundamental disequilibria. At least the last two imply
significant differences with respect to the traditional IMF approach, which is based on the
principle of correcting fundamental balance of payments disequilibria once they have become
evident. Positive measures have been adopted in this area, including a significant expansion of
IMF resources through a quota increase and the New Arrangements to Borrow, which entered
into effect in late 1998; the launching of a the Supplemental Reserve Facility (SRF) in December
1997 to finance exceptional borrowing requirements during crises; and the creation of the
Contingency Credit Line (CCL) in April 1999 to provide financing to countries facing contagion,
though under very restrictive eligibility conditions.
18
/ This important distinction is made by Helleiner (1999) and Eatwell and Taylor (2000). For a fuller discussion of
this issue and its relation to IMF access to adequate resources, see Mohammed (1999).
13
The major controversies relate to inadequate funding, conditions for access and credit
terms. With respect to the first point, bilateral financing and contributions to the IMF will
continue to be scarce during crises. This is a crucial issue, as the stabilizing effects of rescue
packages will be absent if the market deems that the intervening authorities (the IMF plus
additional bilateral support) are unable or unwilling to supply funds in the quantities required. As
bilateral financing and contributions to the IMF will continue to be scarce and unreliable in
crises, the best solution, according to several recent proposals, is to allow additional issues of
SDRs during episodes of world financial stress; these funds could be destroyed once financial
conditions normalize 19/. This procedure would create an anti-cyclical element in world liquidity
management and would give SDRs an enhanced role in world finance, a principle that
developing countries have advocated in the past and should continue to endorse in the future.
Second-best alternatives are to make a more active use of Central Bank swap arrangements under
IMF or BIS leadership, and to allow the IMF to raise the resources needed in the market.
The broad issues raised by conditionality will be discussed in Section IV below.
However, the adequate mix of conditionality and other credit conditions deserves some attention
here. In this regard, the idea that conditionality cum the provision of limited funding should be
mixed with harder terms for exceptional financing –both shorter maturities and higher spreads–
is controversial. This has been the pattern in recent IMF facilities (both the SRF and the CCL). It
has eliminated the “credit union” character of IMF financing but still does not reflect “market
conditions”. It should be recalled in this regard that the classical Bagehot criteria for lending of
last resort relies on short-term financing at penalty interest rates, but on the basis that financing is
unconditional and unlimited (or, to be precise, limited by good collaterals only). Thus, contrary
to current IMF practice, Bahegot criteria consider more onerous credit terms (with unlimited
funding) as a substitute rather than a complement for conditionality (cum limited funding).
Indeed, following ideas closer to these classical criteria, some of the more radical
proposals in this area involve reducing conditionality significantly and moving towards shortterm credit lines, at penalty interest rates 20/. These alternatives are equally controversial. First of
19
/ See United Nations Task Force (1999), Council on Foreign Relations (1999), Meltzer et al. (2000), Camdessus
(2000)
20
/ See, in particular, Meltzer et al. (2000), but also Council on Foreign Relations (1999).
14
all, they also violate one of Bahegot’s criteria: unlimited funding; indeed, these proposals would
restrict financing severely when compared to recent IMF credit lines. Secondly, in some of those
proposals, conditionality is maintained, even including conditions that have been absent in
traditional IMF financing
21
/. Moreover, a basic assumptions of these proposals is that recent
crises have been severe but short
22
/. The alleged fact is debatable
23
/. More importantly, the
characteristics of recent crises ––including their duration–– is certainly not independent of the
rapid response of the international community in the form of larger and faster rescue packages
than in the past (along the “lessons” previously inferred). During the Asian crisis, it was also
associated, as indicated, to the rapid, concerted macroeconomic response of industrialized
countries.
The recent Contingency Credit Line designed to deal with contagion have introduced
similar but also some additional problems. Following, again, traditional “lending of last resort”
criteria, critics have argued that such a credit line should have more onerous credit terms, but
should also be automatic, based on whether countries fulfil certain ex-ante criteria, and thus be
detached from traditional conditionality. The window created recently for this purpose does not
fully meet these criteria: although Article IV consultations were given an enhanced role in
signaling access ex-ante, access still requires negotiations prior to approval by the Board (a
special “activation” review) and an explicit standby agreement. Moreover, countries with current
access to IMF financing were not considered eligible. A more important difficulty is the fact that
ex-ante signalling transforms, in effect, the IMF into a credit rating agency, a fact that could
generate severe destabilizing effects on countries when downgraded. Moreover, performance
indicators that are appropriate before crises may cease to be so once crises strike.
21
/ Thus, Meltzer et al. (2000) would require borrowing countries, as conditions for access, fiscal soundness,
minimum prudential regulation, transparent data on debt and its structure, and freedom of operation for foreign
financial institutions. The latter is absent, not only in current conditionality but in other proposals related to IMF
financing.
22
/ Council on Foreign Relations (1999), ch. III.
23
/ As a matter of fact, commercial bank lending did not normalize in Latin America in the 1990s, despite the boom
in such financing to East and South-East Asia. Moreover, the recovery of bond financing after the Asian crises and
the successive shocks that followed were accompanied by a worsening of credit conditions (particularly higher
spreads but also shorter maturities during the early recovery phase and call options that effectively further shorten
maturities). More broadly, flows experienced a depression of more than two years (so far).
15
This discussion highlights how complex it is for an “emergency financier” (rather than a
true “lender of last resort”) to find the appropriate mix of conditionality, limited funding and
more onerous credit terms. The adequate solution would require: (1) large up-front financing; (2)
no prequalifications but a fast review process during periods of strong contagion; and (3) reduced
conditionality in general, but particularly for those credit lines subject to harsher terms 24/.
D.
Debt standstills and orderly workout procedures
Debt standstills and orderly workouts procedures are an essential mechanism to avoid the
coordination problems implicit in chaotic capital flight, to guarantee an appropriate sharing of
adjustments by private lenders and, thus, to avoid “moral hazard” issues associated with
emergency financing. Broad consensus on the need to create arrangements of this sort exists 25/
but little action has followed. This reflects private sector opposition to non-voluntary
arrangements in industrialized countries, but also the practical difficulties involved in drafting
general rules in this area
26
/. A preference to a “case by case” approach has followed, but this
approach is also clearly inadequate.
Due to the effects that the use of this mechanism could have on their credit standing,
borrowing countries are unlikely to abuse it. Nonetheless, to avoid “moral hazard” issues on the
side of borrowers, it must be subject to international control, by allowing countries to call a
standstill unilaterally but then requiring that they submit it for approval by an independent
international panel or an agreed international authority, whose authorization would give it
legitimacy 27/. An alternative could be to draft ex ante rules under which debt service would be
automatically suspended or reduced if certain macroeconomic shocks were experienced; such
rules have sometimes been incorporated into debt renegotiation agreements.
The active use of these mechanisms has four implications. Firstly, to avoid both free
riding and discrimination against countries or group of countries that adopt them, they require
the universal adoption by borrowing countries of “collective action clauses”, as indeed British
24
/ See a discussion along these lines in Ahluwalia (1999).
/ See the references quoted in footnote 8.
26
/ See a review of some of the controversies involved in IMF (1999, 2000a, 2000b), Boorman and Allen (2000) and
Fischer (1999).
25
16
rules already require. The G-7 countries should actually lead the process, as they suggested in
October 1998
28
/, for otherwise it may become an additional source of discrimination against
“emerging markets”. Secondly, “bailing in” should be encouraged by giving seniority to lending
that is extended to countries during the period in which the standstill is in effect and during a
later phase of “normalization” of capital flows. IMF “lending into arrears” should be considered
as part of “bailing in” operations. Thirdly, the phase of voluntary debt renegotiations under this
framework must have a short, strictly-defined time horizon, beyond which the country in arrears
could request the independent panel or international authority to intervene in the negotiations or
even to determine the terms of rescheduling. Indeed, the basic deficiency of voluntary case-bycase solutions is that the negotiation periods could become extremely long, generating large costs
to developing countries, as the experience of Latin America in the 1980s indicates. Finally, to
avoid repeated renegotiations –another troublesome feature of voluntary arrangements in recent
decades-- aside from the portion that is written off (or refinanced in highly concessional terms),
the service of another portion should be subject to the fulfilment of certain contingent
macroeconomic conditions that determine debt service capacity (e.g., terms of trade,
normalization of lending, domestic economic activity, etc.).
The definition of international rules on capital account regulations and exchange rate
regimes has been left out of this discussion. The reason is that, under the current, incomplete
arrangements, national autonomy should continue to prevail in these areas. They are therefore
considered in Section VI below.
III.
DEVELOPMENT FINANCE
As the discussion presented in Section I indicates, although IMF financing is certainly
important to low-income countries, the major issues for them are associated with the need to
guarantee adequate development finance, through ODA and multilateral lending, and to generate
mechanisms that will allow them to participate more actively in private capital markets. Given
the relative magnitude of financing to low-income countries (see Table 2), the reversal of ODA
flows, particularly those originating in the largest industrialized economies, is certainly the most
27
28
/ UNCTAD (1998), Part I, Chapter IV; United Nations Task Force (1999).
/ Group of Seven (1998).
17
important issue. Thus, it is important that efforts to accelerate HIPC should not crowd out new
ODA financing. Actually, beyond a more ambitious HIPC Initiative, the world requires an even
more ambitious and permanent “ODA Initiative” aimed at effectively meeting internationally
agreed targets. An essential characteristic of this process, as is emphasized in the following
sections, should be an effective “ownership” of policies by developing countries, a fact that
requires less direction from abroad and more emphasis on national institution building. The latter
requires, in turn, respect for the central role that parliaments and Governments in aid-receiving
nations should have in the global allocation of aid through their budgetary processes and the
central role that Governments in those countries should have in directing traditional areas of
public policy (e.g., social policy and infrastructure), even when civil society is given a central
role in execution.
Equally important, however, is the acceleration of the growth of multilateral lending.
Moreover, due to the high concentration of private flows in a few “emerging” economies,
multilateral lending will continue to play an essential role even with respect to middle-income
nations. More broadly, multilateral lending will continue to play a central role in at least four
areas: (1) to channel funds to low-income countries; (2) to correct market failures associated to
overpricing of risks, which may lead to inadequate access to long-term financing by middle
income countries with insufficiently high credit rating and, consequently, to inadequate debt
profiles that increase risks, thus generating “self-fulfilling” low-level equilibria; (3) to act as a
counter-cyclical balance to fluctuations in private capital market financing; and (4) to facilitate
the transition to private financing by supporting some innovations in long-term financing to
developing countries and signalling creditworthiness. To these we should add the traditional
“value added” of multilateral financing: lending-associated technical assistance 29/.
The first of these functions underscores the central role that financing from IBRD-IDA
and the regional and subregional development banks will continue to play in the immediate
future. It has received widespread support in recent debates. The second and third functions
29
/ See, on this, Gilbert, Powell and Vines (1999) who, nonetheless, reject the idea that market failures are an
argument for development lending to middle-income countries. The idea suggested by these authors that there is
some kind of “natural monopoly” in some types of development economics research does not seem, however, a
18
emphasize the role that official development financing will continue to play even for middleincome countries. Some authors reject, nonetheless, the validity of these arguments 30/. The high
interest rates that have characterized private lending to developing countries in the 1990s, and
the much shorter maturities of private vs. official financing to middle-income countries, may
indicate that, on average, risk may have been overestimated (see Table 3) 31/.
Table 3
DEVELOPING COUNTRIES: AVERAGE TERMS OF NEW COMMITMENTS
Average maturity (years)
Official
All developing countries
Income groups
Low income
Middle income
Private
All developing countries
Income groups
Low income
Middle income
Average interest (%)
Official
All developing countries
Income groups
Low income
Middle income
Private
All developing countries
Income groups
Low income
Middle income
1990
1991
1992
1993
1994
1995
1996
1997
1998
22.2
20.9
21.1
21.4
22.1
19.2
21.2
20.1
18.5
27.0
18.8
25.9
17.8
26.8
17.0
25.4
18.1
26.2
18.4
24.4
15.8
26.8
17.2
26.2
17.2
26.6
14.2
13.9
10.2
10.0
9.4
8.9
7.4
8.3
10.0
8.8
13.7
13.9
11.5
9.9
12.3
9.0
11.3
8.4
11.2
8.1
8.0
7.2
7.5
8.6
7.0
10.8
7.0
9.0
5.5
5.5
5.3
4.8
4.9
5.8
4.8
5.4
5.2
4.0
6.6
4.5
6.1
3.8
6.4
3.8
5.6
3.9
5.8
4.5
6.7
3.9
5.6
4.2
6.0
3.7
6.0
8.5
7.8
6.8
6.3
6.3
6.4
7.3
7.3
7.9
7.9
8.8
7.5
7.8
6.7
6.9
6.0
6.4
5.7
6.5
6.4
6.4
6.6
7.5
6.4
7.5
6.9
8.0
Source: World Bank (2000).
It must be stressed, however, that the anti-cyclical provision of funds should not be
confused with the provision of emergency balance of payments financing, which is essentially a
task of the IMF. However, to the extent that anti-cyclical fiscal policies are a necessary element
in counter-cyclical macroeconomic management in general, there may be an argument for
sensible defense of the World Bank. The parallel idea that global public goods should be provided is certainly valid,
but it justifies the existence of many types of international institutions, not development banks per se.
30
/ The strongest argument in this regard is that of Meltzer et al. (2000) but a weaker version can be found in Gilbert,
Powell and Vines (1999), who nonetheless argue that the World Bank should be allowed to lend to middle-income
countries to improve its portfolio.
19
development financing during crisis as a counterpart to pure balance of payments financing 32/.
An alternative would be to allow IMF financing –or the latitude it offers for domestic credit
creation– for fiscal purposes, but this step would be suboptimal. In any case, the large-scale
requirements for counter-cyclical financing to middle-income countries during crises may crowd
out financing to poor countries, a point which has been made by the President of the World
Bank 33/. Thus, if multilateral development financing is not significantly expanded, its role as a
counter-cyclical device will necessarily be very limited, and it would certainly be of secondary
importance relative to its first two roles, particularly the provision of long-term development
financing to poor countries. This is underscored by the data from Table 2, which indicate that
multilateral financing in 1992-1998 represented only 15% of that provided by the private sector,
excluding FDI, and only 8% in the case of middle-income countries. Thus, a useful
counter-cyclical function would certainly require a significant increase in resources available to
multilateral development banks or a more active use of cofinancing and credit guarantees by
these institutions (see below).
The role of development banks in social safety nets, which has received a correct
emphasis in recent discussions, should be seen as part of the counter-cyclical role that
development banks should play. Strong social safety nets are, indeed, essential to manage the
social repercussions of financial vulnerability in the developing world. The concept itself is
subject to some confusion, as it has been used to refer both to the design of long-term social
policies and to specific mechanisms to protect vulnerable groups during crises. The term should
probably be used to refer specifically to the latter, although, as we will argue below, these
arrangements should be part of stable mechanisms of social protection. Multilateral banks have
been involved in the former for a long time and have also accumulated some experience with the
latter.
31
/ Indeed, it is peculiar that Meltzer et al (2000) estimate the subsidies of development financing in the 1990s by
assuming that it is equivalent to only half of spreads in capital markets.
32
/ Such financing could be tied to broader forms of anti-cyclical management, on the basis of counterpart savings in
the countries accumulated during the previous boom or repayment conditions that would require acceleration of
amortizations if fiscal revenues experience a strong recovery during a subsequent boom.
33
/ Wolfensohn (1998).
20
Recent analyses have come to some basic conclusions about these programs. Firstly,
safety nets must be part of permanent social protection schemes, as only a permanent scheme
guarantees that the program coverage will respond without lags to the demand for protection of
vulnerable sectors during crises
34
/. Secondly, given the heterogeneity of labor markets in
developing countries, a combination of several programs, with different target groups, is
necessary
35
/. Thirdly, these programs must be adequately financed and should not crowd out
resources from long-term investment in human capital. This, it must be said, leads to a fourth
conclusion: that the effective functioning of social safety nets requires that public-sector
expenditure should include anti-cyclical components. This would be impossible, without
generating inefficiencies in the rest of public-sector expenditure, if fiscal policy as a whole is not
counter-cyclical. In the absence of this anti-cyclical fiscal pattern, external financing from
development banks during crises to safety nets will be unnecessary, as overall net fiscal
financing requirements will actually decrease despite the increased spending associated to such
safety nets.
The fourth function is of fairly recent origin but has been rapidly gaining in importance in
the 1990s and should become one of the primary focuses of multilateral financing in the future.
This function has been associated in the recent past with direct financing or cofinancing to the
private sector (by banks or associated financial corporations) or with the design of guarantee
schemes to support private infrastructure projects in developing countries. It has also been
recently used to support developing countries’ efforts to return to markets after crises and could
be used to support initial bond issues by developing (particularly poor) countries seeking to
position themselves in private capital markets. It must be emphasized, however, that the full
development of these guarantee schemes would require a radical change in the management of
guarantees by development banks, as, under current practices, guarantees are treated as
equivalent to lending, a fact which severely restricts the banks’ ability to extend them. Such an
expansion of the role of development banks in guaranteeing private financing has been criticized
34
/ Cornia (1999).
/ Márquez (1999). Different groups would be supported by unemployment insurance, emergency employment or
emergency labor-intensive public works programs, income-support schemes in conjunction with training, and
special targeted subsidies (such as some nutrition programs, subsidies to households with school-age children that
are tied to school attendance, and various support programs aimed at ensuring that households with an unemployed
head of household do not lose their home during crises, etc.).
35
21
on the grounds that it could involve excessive risk-taking by these institutions. Nonetheless, in a
world that will be dominated by private financing, it may be absolutely essential to prevent lowincome countries from being left out of major developments in capital markets and to facilitate a
more active anti–cyclical role for development banks. It should thus receive priority attention in
current discussions.
IV.
CONDITIONALITY VS. “OWNERSHIP”
The most controversial issue behind international emergency and development financing
is certainly conditionality. In the case of the IMF, this issue has long been a central area of
contention. However, in recent years –and even decades– the issue has become increasingly
troublesome for three different reasons. Firstly, the scope of conditionality has been gradually
expanded to include not only the realms of other international organizations –quite often, for
example, that of the WTO and the development banks– but also of domestic economic and social
development strategies and institutions which, as the United Nations Task Force has indicated,
“by their very nature should be decided by legitimate national authorities, based on broad social
consensus”
36
/. The broadening of conditionality to social policy, governance issues and private
sector involvement in crisis resolution has been criticized by developing countries in the Group
of 24 37/. The need to restrict conditionality to macroeconomic policy and financial sector issues
is shared by a broad group of analysts with quite different persuasions as to the future role of the
IMF 38/. A similar view was expressed in the external evaluation of surveillance activities of the
Fund 39/.
Secondly, whereas the legitimacy of conditionality is indisputable when domestic
policies are the source of macroeconomic disequilibria that lead to financial difficulties, as well
as being necessary to avert “moral hazard” issues, it is unclear how this principle applies when
such difficulties are generated by international crises and, particularly, by contagion effects.
Thirdly, as has already been pointed out, it is even less clear why conditionality should be mixed
with adverse credit terms. Finally, many observers have criticized overkill in some IMF
36
/ United Nations Task Force (1999), Section 5.
/ Group of 24 (1999b).
38
/ Council on Foreign Relations (1999), Meltzer et al. (2000), Collier and Gunning (1999), Feldstein (1998),
Helleiner (2000b) and Rodrik (1999b).
37
22
programs, a fact which has led the Fund to allow some room for anti-cyclical fiscal policies in its
adjustment programs 40/.
Even if the legitimacy of the principle of conditionality –or, as it is sometimes stated,
“support in exchange for reforms”– is accepted, there are thus reasons to review the
characteristics of such conditionality. Indeed, the perception that conditionality has been carried
beyond what may actually be necessary in order for the Fund to perform its functions properly
may be helping to undermine its legitimacy. Thus, a strong argument can be made that the way
to restore full confidence in the principle of conditionality is by reaching a renewed international
agreement on how it should be used.
Several principles can be advanced in this regard. Firstly, as noted, IMF conditionality
should be restricted to the macroeconomic policies that were its purview in the past. Reforms of
domestic prudential regulation and supervision may also be required, but in this case parallel
agreements should be made with the corresponding international authorities (a still controversial
issue, as we have seen). Secondly, low-conditionality facilities should be available in adequate
quantities when the source of the imbalance is an international shock or a country faces
contagion. Nonetheless, beyond and above the pre-established level of the low conditionality
facilities, access to Fund resources could be subject to macroeconomic conditionality on
traditional terms. Thirdly, as we have also noted, more stringent credit terms should not be used
as a complement to conditionality. Fourthly, automatic rules should be agreed upon when
signing an agreement with the Fund under which the restrictiveness of the adjustment program
would be eased should evidence of overkill become clear. Finally, regular official evaluation of
IMF programs, by an autonomous division of the Fund (a decision already adopted in 2000) and
by outside analysts should be the basis for a regular revision of the nature of conditionality.
It must be emphasized that similar issues have been raised in relation to development
finance. With respect to this issue, a recent World Bank report which analyses the success of
structural lending, according to its own evaluation, comes to the conclusion that conditionality
39
40
/ Crow, Arriazu and Thygeseb (1999).
/ Fischer (1998).
23
does not influence the success or failure of such programs at all 41/. Nonetheless, according to the
same report, aid effectiveness is not independent of the economic policies that countries follow.
In particular, the growth effects of aid are higher for countries that adopt “good” policies, which,
according to their definition, include stable macroeconomic environments, open trade regimes,
adequate protection of property rights and efficient public bureaucracies that can deliver goodquality social services. In the context of good policies, there is an additional positive effect of aid
that is manifested through the “crowding in” of private financing. Neither of these effects are
present, however, in countries following “wrong” policies. In terms that are now familiar in the
aid literature, the ownership of adequate economic policies, i.e., the commitment of national
authorities to them, is what really matters. Conditionality has no additional contribution to make
in these cases, and it is obviously ineffective in the case of countries that do not follow good
policies.
Curiously enough, on the basis of this study the World Bank draws the conclusion that
conditionality is good after all. Hence, it claims that “Conditional lending is worthwhile where
reforms have serious domestic support”
42
/ and, in particular, that it “still has a role –to allow
government to commit to reform and to signal the seriousness of reform—but to be effective in
this it must focus on a small number of truly important measures”. 43/ This statement is certainly
paradoxical if the conclusions of the report are taken at face value. Rather, this study raises
serious doubts about the rationality of conditionality itself, a fact that is, indeed, implicit in the
idea that policies are only effective when they are rooted in broad national consensus, the
essential idea that has been captured in the concept of “ownership” 44/. Indeed, the President of
the World Bank has made the strongest statement in this regard: “We must never stop reminding
ourselves that it is up to the governments and its people to decide what their priorities should be.
We must never stop reminding ourselves that we cannot and should not impose development by
fiat from above –or from abroad” 45/.
41
/ See World Bank (1998b), Chapter 2 and Appendix 2. See also Gilbert, Powell and Vines (1999) and Stiglitz
(1999).
42
/ World Bank (1998b), p. 48.
43
/ World Bank (1998b), p. 19.
44
/ See a full discussion of these issues in Helleiner (1999).
45
/ Wolfensohn (1998).
24
A recent analysis by Rodrik has come to complementary conclusions which are extensive
to short-term macroeconomic policies
46
/. Aside from arguing that international arrangements
should allow for diversity in national development strategies (different “brands of capitalism”),
this author makes a strong argument that adequate institutions of conflict management, which
can only be guaranteed by national democratic processes, are crucial for macroeconomic stability
and that this, in turn, is vital for economic growth. To borrow the term, the “ownership” of
adjustment programs is also essential to guarantee their political sustainability.
The issue of conditionality vs. ownership is, indeed, essential to the broader objectives of
democracy at the world level. There is clearly no sense in promoting democracy if the
representative and participatory processes at the national level are given no role in determining
economic and social development strategies, as well as the particular policy mix by which
macroeconomic stability is obtained. Both of them may not only be relatively ineffective but will
also lack political sustainability if international institutions or the aid agencies of the
industrialized countries play this role.
V.
THE ROLE OF REGIONAL INSTITUTIONS
There are three basic arguments in support of a strong role for regional institutions in the
new financial order. The first one is that globalization also entails open regionalism. The growth
of intraregional trade and direct investment flows are, indeed, striking features of the ongoing
globalization process. This factor increases macroeconomic linkages and thus the demands for
certain services provided by the international financial system which we have analysed in
previous sections: macroeconomic surveillance and internalization of the externalities that
national macroeconomic policies have on neighbouring countries, and mutual surveillance of
each other’s mechanisms for the prudential regulation and supervision of the financial system.
Secondly, some of these services may be subject to diseconomies of scale and it is
unclear whether others have strong scale economies to justify single international institutions in
specific areas (i.e., natural monopolies). Traditional issues of subsidiarity are thus raised. For
example, macroeconomic consultation and surveillance at the world level may be necessary to
46
/ Rodrik (1999a).
25
guarantee policy coherence among major industrialized countries, but it would certainly be
inefficient to manage the externalities generated by macroeconomic policies on neighbours in the
developing world (or even within Europe). Due to differences in legal traditions and the sheer
scale of the diseconomies involved, surveillance of national systems for the prudential regulation
and supervision of financial sectors, and even the definition of specific minimum standards in
this area, may be dealt with more appropriately with the support of regional institutions.
Development finance can operate effectively at different scales and, as we will see, can perform
certain functions at regional and subregional levels that could not be performed at the
international level. Also, although regional and international contagion implies that the
management of the largest balance of payments crises should be assigned to a single world
institution, it is unclear how far we should push this assertion. Strong regional institutions can
serve as regional buffers, as the post-war Western European experience indicates. Regional
reserve funds or swap arrangements can also play a useful role in the developing world and, if
expanded, could even provide full support to the small and medium-size countries within some
regions. Also, as the rising concentration of balance of payments support in a few countries
indicates (see Section I), there may be biases in the response of the international community
according to the size of the country, a fact which would argue for a division of labor in the
provision of services in this area between world and regional organizations.
Thirdly, for smaller countries, the access to a broader menu of alternatives to manage a
crisis or to finance development is relatively more important than the “global public goods” that
the largest international organizations provide (e.g., global macroeconomic stability) and upon
which they will assume they have little or no influence (i.e., they have the attitude of “free
riders”). Due to their small size, their negotiation power vis-à-vis large organizations would be
very limited, and their most important defense is therefore competition in the provision of
financial services from such institutions.
The current discussion has underscored the fact that some services provided by
international financial institutions, including some “global public goods”, are being
undersupplied. However, according to previous remarks, it would be wrong to conclude from
this statement that the increasing supply should come from a few world organizations. Rather,
26
the organizational structure should have, in some cases, the nature of networks of institutions that
provide the services required on a complementary basis and, in others, should function as a
system of competitive organizations. The provision of the services required for financial crisis
prevention and management should be closer to the first model, whereas, in the realm of
development finance, competition should be the basic rule (and, in fact, should include
competition with private agents as well). But purity in the model’s structure is probably not the
best characteristic: it is desirable that parts of networks compete against each other (e.g., regional
reserve funds or swap arrangements vs. the IMF in the provision of emergency financing) and
that competitive organizations cooperate in some cases.
This implies that the International Monetary Fund of the future should not be viewed as a
single, global institution, but rather as the apex of a network of regional and subregional reserve
funds and swap arrangements. To encourage the development of the latter, incentives could be
created by which common reserve funds could have automatic access to IMF financing and/or a
share in the allocation of SDRs proportional to their paid-in resources –in other words,
contributions to common reserve funds would be treated as equivalent to IMF quotas
47
/. As
noted, regional reserve funds or swap arrangements could provide most of the exceptional
financing for smaller countries within a region, but also part of the financing for larger countries,
and they could also serve to deter, at least partly, would-be speculators from attacking the
currencies of individual countries.
This model should be extended to the provision of macroeconomic consultation and
surveillance, as well as to coordination and surveillance of national systems of prudential
regulation and supervision. Thus, regional and subregional systems, including peer review
mechanisms, should be designed to internalize the externalities that macroeconomic policies
generate on neighbours. This would complement, rather than substitute for, regular IMF
surveillance. In the area of prudential regulation and supervision, more elaborate systems of
regional information and consultation, including the design of specific regional “minimum
standards”, can also play a positive role. Again, peer reviews should be part of this system. Aside
from other functions considered in Section III, subregional development banks can play a
47
/ United Nations Task Force (1999), Section 9; Ocampo (2000a).
27
significant role as a mechanism to pool the risks of groups of developing countries, thus allowing
them to make a more aggressive use of opportunities provided by private capital markets.
As it is well known, Western Europe provides the best example of regional financial
cooperation in the post-war period. The U.S., through the Marshall Plan, catalysed the initial
phases of this process, which underwent a dynamic deepening from the design of the European
Payments Union to a series of arrangements for macroeconomic coordination and cooperation,
that eventually led to the current monetary union of most of its members. No similar schemes
have been devised in the rest of the world, although some proposals have been made, the most
ambitious of which was the Japanese suggestion to create an Asian Monetary Fund. The most
interesting development in recent years has been the swap arrangement among thirteen Asian
countries agreed in May 2000
48
/ and initiatives to strengthen the Latin American (previously
Andean) Reserve Fund 49/.
An institutional framework such as that suggested would have two positive features. First
of all, it may help to bring more stability to the world economy by providing essential services
that can hardly be provided by a few international institutions, particularly in the face of a
dynamic process of open regionalism. Secondly, from the point of view of the equilibrium of
world relations, it would be more balanced than a system based on a few world organizations.
This would increase the commitment of less powerful players to abide by rules that contribute to
world and regional stability.
VI.
THE REALMS OF NATIONAL AUTONOMY
Whatever international system is developed, it is clear that it will continue to be a very
imperfect “financial safety net”. Consequently, a degree of “self-insurance” by countries will
continue to be essential to avoid financial crises, as well as to avoid “moral hazard” issues
intrinsic to any support scheme. This raises two issues as to the national policies necessary to
guarantee financial stability and the areas where national autonomy should be maintained. We
will argue that the international system should continue to maintain national autonomy in two
48
49
/ Park and Wang (2000).
/ Agosin (2000) and ECLAC (2000b, ch. 2).
28
crucial areas: the management of the capital account and the choice of the exchange rate regime.
The choice of development strategies is obviously an additional, essential realm in which
national autonomy should prevail, as the analysis in Section IV has emphasized.
The experience of developing countries indicates that the management of capital account
volatility requires: (1) consistent and flexible macroeconomic management; (2) strong prudential
regulation and supervision of domestic financial systems; and (3) equally strong “liability
policies”, aimed at inducing good public and private external and domestic debt profiles
50
/.
Despite the traditional emphasis on crisis management, the focus of the authorities should instead
be the management of booms, since it is in the periods of euphoria of capital inflows, trade
expansion and terms-of-trade improvements that crises are incubated. Crisis prevention is thus,
essentially, an issue of the adequate management of periods of euphoria.
In this regard, regulations on capital inflows may be essential to avoid unsustainable
exchange rate appreciation during booms. Although some appreciation may be inevitable and
even an efficient way to absorb the increased supply of foreign exchange, an excessive
revaluation may also generate irreversible “Dutch disease” effects. The regulation of capital
inflows thus plays an essential role in open developing economies as a mechanism for monetary
and domestic credit restraint and for the avoidance of unsustainable exchange rate appreciation
during booms. The nature of such regulations will be considered below. Regulations governing
outflows may also play a role as a way to avoid overshooting interest or exchange rates during
crises, which may have adverse macroeconomic dynamics, including the greater risk of domestic
financial crises; they are also essential to put in place debt standstill and orderly debt workout
procedures. It is essential, of course, that capital account regulations be used as a complement
and not a substitute for fundamental macroeconomic adjustment.
As was pointed out in Section II, prudential regulation and supervision must take into
account not only the micro- but also the macroeconomic risks typical of developing countries. In
particular, due account should be taken of the links between domestic financial risk and changes
50
/ The literature on national policies is extensive. See, among recent contributions, ECLAC (2000a, ch. 8); World
Bank (1998a), Chapter 3; Ffrench-Davis (1999); Helleiner (1997); and Ocampo (1999, 2000b).
29
in key macroeconomic policy instruments, notably exchange and interest rates. The risks
associated with the rapid growth of domestic credit, currency mismatches between assets and
liabilities, the accumulation of short-term liabilities in foreign currencies by financial
intermediaries and the valuation of fixed assets used as collateral during episodes of asset
inflation must also be adequately taken into account. Depending on the operation, higher capital
adequacy requirements, matching liquidity requirements or caps on the valuation of assets should
be established. Moreover, given these macroeconomic links, prudential regulations should be
strengthened during years of financial euphoria to take into account the increasing risks being
incurred by financial intermediaries. These links also imply that the application of contractionary
monetary or credit policies during booms (e.g., higher reserve requirements or ceilings on the
growth of domestic credit) may be highly complementary to stricter prudential regulation and
supervision. Moreover, due to the important externalities which large non-financial firms could
generate to the domestic financial sector, particularly in the context of exchange rate
depreciation, the external liability exposure of these firms should also be subject to some
regulation. Tax incentives (e.g., limits on the deductibility of exchange-rate losses) and rules that
force non-financial firms to disclose information on their external liabilities may thus be relevant
complements to appropriate prudential regulation and supervision of financial intermediaries.
The experience of many developing countries indicates that crises are associated not only
with high debt ratios but also with inadequate debt profiles 51/. The basic reason for that is that,
under uncertainty, financial markets respond to gross –rather than only to net-- financing
requirements, or in other words, the rollover of short-term debts is not neutral in financial terms.
This gives an essential role to “liability policies” aimed at improving debt profiles. Although
improving the external debt profile should be the central role of such policies, there is a strong
complementary between good external and internal debt profiles. Hence, excessive short-term
domestic borrowing may force a Government that is trying to rollover debt during a crisis to
raise interest rates in order to avoid capital flight by investors in government bonds. Also,
excessively high short-term private liabilities increase the risks perceived by foreign lenders
during crises, a fact that may induce a stronger contraction of external lending.
51
/ See an excellent recent treatment of this issue in Rodrik and Velasco (1999).
30
In the case of the public sector, direct controls by the Ministry of Finance are an
appropriate instrument of a liability policy. Exchange rate flexibility may deter some short-term
private flows and may thus partly operate as a “liability policy”, but its effects are limited in this
regard, as it is unlikely to smooth out medium-term financial cycles, which will be reflected in a
parallel cycle of nominal and real exchange rates. Direct controls on inflows may also be an
appropriate instrument to achieve a better private debt profile. An interesting, indirect pricebased policy tool is reserve requirements on capital inflows, such as those used by Chile and
Colombia in the 1990s. These requirements are a particular type of Tobin tax, but the equivalent
tax rate (3% in the case of Chile for one-year loans and 10% or more in Colombia during the
boom) is much higher than that proposed for an international Tobin tax. A flat tax has positive
effects on the debt profile, as it induces longer-term borrowing, for which the tax can be spread
over a longer time period, and is easier to administer. The effects of this system on the
magnitude of flows have been the subject of a heated controversy. In any case, since tax
avoidance is costly and short- and long-term borrowing are not perfect substitutes, the magnitude
of flows –or, what is equivalent, interest arbitrage conditions– should also be affected 52/. A basic
advantage of this instrument is that it is targeted at capital inflows and is thus a preventive policy
tool. It also has specific advantages over prudential regulations that could have similar effects: it
affects both financial and non-financial agents, and it uses a non-discriminatory price instrument,
whereas prudential regulations affect only financial intermediaries, are usually quantitative in
nature and supervision is essentially discretionary in its operation 53/.
Simple rules are preferable to complex ones, particularly in underdeveloped regulatory
systems. In this sense, quantitative controls (e.g., flat prohibitions on certain activities or
operations) may be preferable to sophisticated price-based signals, but simple price rules such as
the Chilean-Colombian system can also play a role. Any regulatory system must also meet an
additional requirement: it must have adequate institutional backing. A permanent system of
capital account regulations, which can be strengthened or loosened throughout the business
52
/ Agosin (1998), Agosin and Ffrench-Davis (2000), Le Fort and Lehman (2000), Ocampo and Tovar (1998, 1999),
and Villar and Rincón (2000).
53
/ Ocampo (2000a). Indeed, this instrument is similar to practices used by private agents, such as the sales fees
imposed by mutual funds on investments held for a short period in order to discourage short-term holdings. See
J.P.Morgan (1998), p. 23.
31
cycles, is thus preferable to the alternation of free capital movements during booms and
quantitative controls during crises. Indeed, the latter system may be totally ineffective if
improvised during a crisis, simply because the administrative machinery to make it effective is
not operative, and it may thus lead to massive evasion or avoidance of controls. Such a system is
also pro-cyclical and leaves aside the most important lesson learned about crisis prevention:
avoid overborrowing during booms and thus target primarily capital inflows rather than
outflows.
Obviously, capital account regulations are not foolproof, and some developing countries
may prefer to use policy mixes that avoid their use (e.g., more active use of fiscal and exchange
rate policies, as well as alternative prudential regulations) or may prefer a less interventionist
environment even at the cost of greater GDP volatility. Thus, the most compelling argument that
can be derived from this analysis is the need to maintain the autonomy of developing countries to
manage their capital accounts.
There are actually no strong arguments in favour of moving towards capital account
convertibility
54
/. There is no evidence that capital mobility leads to an efficient smoothing of
expenditures in developing countries through the business cycle and, on the contrary, strong
evidence that in these countries the volatility of capital flows is an additional source of
instability. There is also no evidence of an association between capital account liberalization and
economic growth, and there are some indications that point in the opposite direction 55/. A simple
way to pose the issue is to argue that, even if it were true that freer capital flows, through their
effects on a more efficient savings-investment allocation process, have positive effects on
growth, the additional volatility associated with freer capital markets has the opposite effect. The
absence of an adequate international financial safety net is an equally important argument in this
connection. Why should developing countries give up this degree of freedom if they do not have
access to adequate amount of contingency financing with well-defined conditionality rules, and
no internationally agreed standstills and debt workout procedures? This is a crucial issue for
54
/ For a more extensive analysis of this subject, see United Nations Task Force (1999), UNCTAD (1998), Part One,
Chapter IV, ECLAC (1998), Part III, IMF (1999), Eichengreen (1999), Griffith-Jones (1998), Grilli and MilesiFerreti (1995), Krugman (1998a, 1998b), Ocampo (2000a) and Rodrik (1998).
32
countries without significant power in the international arena, for whom renouncing any possible
means of crisis management is a costly alternative. Indeed, there are strong similarities between
today’s international financial world and the era of “free banking” at the national level: in the
absence of central banks as lenders of last resort and officially managed bank rescue schemes,
inconvertibility of private bank notes was a necessary legal alternative in the face of bank runs.
Similar arguments could be used to claim that there are no grounds for limiting the
autonomy of developing countries to choose their exchange rate regime. There are certainly
virtues to the argument that, in the current globalized world, only convertibility regimes or
totally free-floating exchange rate regimes can generate sufficient credibility in the eyes of
private agents. However, any international rules in this area would be unfortunate. The
advantages and disadvantages of these extremes, as well as of interventionist regimes in between
the two, have been subject to extensive historical debate (and, of course, experience)
56
/. In
practice, countries almost invariably choose intermediate regimes, a fact that can probably be
traced back not only to the deficiencies of the extremes, but also to the many additional demands
that authorities face
57
/. The choice of the exchange rate regime has, nonetheless, major
implications for economic policy that must be recognized in macroeconomic surveillance.
Particularly, as we have noticed, domestic prudential regulations must take into account the
specific macroeconomic risks that financial intermediaries face under each particular regime.
VII.
CONCLUSIONS
This paper has argued that the agenda for international financial reform must be
broadened in at least two senses. First of all, it should go beyond the issues of financial
prevention and resolution, on which the recent debate has focused, to those associated with
development finance for poor and small countries, to overcome the strong concentration of
private and even official financing in a few large “emerging” economies, and to the “ownership”
of economic and development policies by countries. Secondly, it should consider, in a systematic
55
/ See, in particular, Eatwell (1996), Eatwell and Taylor (2000), Rodrik (1998) and, for Latin America, Ocampo
(1999).
56
/ Velasco (2000) provides a recent survey of the issues involved.
57
/ The best conclusion on this subject is, thus, that reached by the IMF (2000a): “No single regime is appropriate for
all countries or in all circumstances”. See also ECLAC (2000b, ch. 2) and, for a recent defense of intermediate
regimes, Williamson (2000).
33
fashion, not only the role of world institutions but also of regional arrangements and the explicit
definition of areas where national autonomy should be maintained. These issues should be tabled
in a representative, balanced negotiation process.
In the area of financial crisis prevention and resolution, a balance must be struck between
the current emphasis on the need to improve the institutional framework in which financial
markets operate and the still insufficient attention to or action on the design of appropriate
schemes to guarantee the coherence of macroeconomic policies worldwide, the enhanced
provision of emergency financing during crises, and the creation of adequate debt standstill and
orderly debt workout procedures. In the area of development finance, emphasis should be given
to the need to increase funding to low-income countries, including the use of multilateral
development finance to support increased participation of low-income and small middle-income
countries in private capital markets. The role of multilateral development banks in countercyclical financing, particularly to support to social safety nets during crises, must also be
emphasized. The enhanced provision of emergency and development financing should be
accompanied by a renewed international agreement on the limits of conditionality and a full
recognition of the central role of the “ownership” of development and macroeconomic policies
by developing countries.
It has also been argued that regional and subregional institutions should play an essential
role in increasing the supply of “global public goods” and other services in the area of
international finance. The required financial architecture should in some cases have the nature of
a network of institutions that provide the services required in a complementary fashion (in the
areas of emergency financing, surveillance of macroeconomic policies, prudential regulation and
supervision of domestic financial systems, etc.), and in others (particularly in development
finance) should exhibit the characteristics of a system of competitive organizations. The fact that
any new order would continue to have the characteristics of an incomplete “financial safety net”
implies both that national policies would continue to play a disproportionate role in crisis
prevention and that certain areas should continue to be realms of national autonomy, particularly
capital account regulations and the choice of exchange rate regimes. Regional institutions and
national autonomy are particularly important for the smaller players in the international arena,
34
which will gain significantly from competition in the services provided to them and from the
maintenance of freedom of action in a context of imperfect supply of global public goods.
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